Microsoft's Midlife Crisis

Steven
Ballmer
Steven Ballmer
, Microsoft's cheerleader and chief executive, takes the stage at the Georgia Dome in Atlanta to stoke the spirits of 10,000 faithful at the company's annual sales meeting. "Win, drive, innovate, impress!" he shouts, his forehead glistening under hot stage lights as ponds of sweat soak the pale blue shirt on his barrel-chested frame. "But there's a way people keep score. Billions! Billions! Billions! If you wanna grow, things that rhyme with 'billions' are very good," he roars, sprinting up and down the aisles to trade high fives with starstruck salespeople.

The crowd at the Georgia Dome loves it, but even Ballmer's booming voice can't mask the disturbing truth: Microsoft
is slowing down. It is bigger, more lumbering and less profitable than it was five years ago. Its sales are up 73% in five years, but profits are up only 30%. Payroll has doubled in the last six years. In the fiscal year just ended, sales rose only 8%, the first time the company has ever reported less than double-digit growth.

In the dog years of Silicon Valley, Microsoft, at 30, is in advanced middle age. The company relies on Windows and a suite of desktop applications--products released a decade ago--for 80% of sales and 140% of profits. Newer products--the Xbox videogame machine, the MSN online service, the wireless and small-business software--collectively have racked up $7 billion in losses in four years.

In Web-server software, Microsoft has 20% of the fast-growing market, while the free Apache program, a Linux variant, has 70%--worth $6 billion in revenue had Microsoft gotten the sales. In search,
Google
and
Yahoo!
get 70% of queries while MSN gets only 13%. Google now gives away features (desktop search, photo archiving) that Microsoft promises in its next upgrade of Windows--which is running two years late.

What has gone wrong? Microsoft, with $40 billion in sales and 60,000 employees, has grown musclebound and bureaucratic. Some current and former employees describe a stultifying world of 14-hour strategy sessions, endless business reviews and a preoccupation with PowerPoint slides; of laborious job evaluations, hundreds of e-mails a day and infighting among divisions so fierce that it hobbles design and delays product releases. In short, they describe precisely the behavior that humbled another tech giant:
IBM
in the late 1980s. Tellingly, IBM reached a point of crisis just over three decades after it started selling computers to commercial users.

"Microsoft is a vestige of the past," says Marc Benioff, chief of rival Salesforce.com, whose shares, since they were first offered to the public in June of last year, are up 27%; Microsoft's are down 5% in that period. Salesforce, which trades at 84 times next year's earnings (versus 20 for Microsoft), rents its software to businesses over the Internet. "Microsoft," Benioff says, "still wishes the Internet hadn't been invented."

"Microsoft has become what it used to mock," says Gabe Newell, a developer on the first three versions of Windows. At late-night rounds of poker with "Bill and Steve" in the mid-1980s, he says, "we laughed at IBM. They had all this process for monitoring productivity, and yet we knew they had spectacularly bad productivity. That's Microsoft now."

Jeff B. Erwin, who quit in December after five years there, adds, "Microsoft has some of the smartest people in the world, but they are just crushing them. You have a largely unhappy population."

Unhappy because they aren't getting rich the way they did in the 1990s. In September 2003 Microsoft ended its stock option program, replacing it with outright grants of shares, which aren't at the moment minting very many millionaires. Since the tech crash in 2000, Microsoft stock has lost half of its value, although it has done better than the next four entries in the March 2000 ranking of Nasdaq stocks by market capitalization:
Cisco
,
Intel
,
ITC DeltaCom
and
Oracle
. And now it is being eclipsed, in software cool and stock market excitement, by the upstart Google.

The doubts and the sniping gnaw at Ballmer, 49, who became chief executive six years ago, just as the tech sector was peaking on Wall Street. "The one thing that frustrates me is any sense that the company doesn't have huge, amazing opportunity to change the world and huge, amazing opportunity to grow," he says. "We absolutely do. Will we execute well? That's my job."

In many ways, Microsoft still looks invincible--its stock may even be a bargain. Surely it has the wherewithal to buy its way into new fields. Even after paying a $32 billion dividend last year, Microsoft has $40 billion in its pocket. With annual net income of $12 billion-plus, it outearns every other technology company.

Moreover, the next 18 months could be filled with blockbusters. Fifteen product releases are set, including new versions of Windows, Office and the SQL database; the much-hyped Xbox 360 is to debut this holiday season. Microsoft is at its best when a new threat looms--as Netscape did a decade ago--and now it has the next one. Ballmer revs up the troops with a new battle cry: "Goo-GLE! Goo-GLE! Goo-GLE!"

"Tone comes from the top," he says. "People have to be reminded that there's nothing that stands in our way of competing. Our capacity to learn is amazing."

Ballmer is one of the richest men in the world. His 3.78% stake in his employer is worth $11 billion.
Bill
Gates
Bill Gates
owns 9.42% and, with other assets, has a net worth of $51 billion. And while Gates sells 20 million shares every quarter to diversify his assets, Ballmer rarely disposes of shares, and even then mainly for charitable purposes. He drives a seven-year-old Ford to the office every day.

Ballmer grew up in the suburbs of Detroit, one of two children; his father was a manager at
Ford Motor
, his mother raised the kids. Steve and Bill bonded at Harvard in their sophomore year. Bill dropped out, while Steve dutifully stayed on. Ballmer graduated in 1977, did a stint at
Procter & Gamble
and entered the Stanford Graduate School of Business in 1979. In 1980 Gates persuaded him to ditch the M.B.A. program and join Microsoft as employee No. 30.

For two decades Ballmer was Bill Gates' right hand. He headed sales for Windows 95, then became president in 1998. In January 2000 Gates ceded the chief exec role in order to focus on the big picture. They talk or e-mail each other daily, and Ballmer consults with Gates even on small acquisitions.

In Gates' grip the old Microsoft ran like a startup, even though it had long ceased to be one. A decision as small as hiring a product-marketing manager required approval from the very top. "There was no management structure," says Mich Mathews, a 12-year veteran who now heads marketing. "We were very hierarchical. If a guy in France wanted to do something, that had to go through Steve."

Shortly after Ballmer took charge, he began looking at how to build some structure into an unwieldy management process. He interviewed a hundred employees at all levels. What emerged was an attempt to create a system with both accountability and flexibility. He recast the company into seven divisions and ordered each to publicly disclose a quarterly profit-and-loss statement, even though accounting rules don't require such revelations.

"This will be a place with some structure, but structure that aids teamwork, not politics and bureaucracy," Ballmer told employees in a companywide e-mail in June of last year. "Nothing solves big company' ills quite like a strong focus on accountability for results with customers and shareholders."

With accountability, though, comes competition for resources. The seven divisions act as rival fiefs, pursuing overlapping technologies and warring over whose code will prevail in the spaces where different divisions' products interact. "Windows and Office would never let MSN have more budget or more control," says Mark Jen, who quit Microsoft eight months ago. "MSN e-mail should talk to Office Calendar contacts and share appointments from Office with friends and family on the Web. But then MSN could cannibalize Office."

The squabbling is delaying the release of the next version of Windows, called Vista. In 2001 Microsoft promised that Vista would be ready in 2003; by mid-2003 it said 2005. Now Vista is set for year-end 2006, the company vows; some analysts say early 2007 is more likely.

Some employees complain that they spend hours tracking down collaborators in far-flung groups instead of talking to customers and taking products to market. Working on a huge project requires checking in with management constantly. "Instead of promoting the product to customers, I'd get stuck in the office until midnight preparing slides for my monthly product review," says David Ryan, 33, a marketer for Windows XP. He has just been freed up to pursue an incubation project in the server group, where he is happily exempt from most reviews. At Microsoft a "review" is often a progress report illustrated with 15 PowerPoint slides.

Other staffers say that almost every move requires a lawyer's signature and that even routine approvals can take weeks. Recently one employee waited a month while a $10,000 purchase order for outside development work was held up by legal. By the time the lawyers were done, the budget for the deal had evaporated. Dennis Reno left Microsoft two years ago feeling burned out from bureaucracy. He'd worked 18-hour days but got little done because he was bogged down by paperwork. "The smallest issue would balloon into a nightmare of a thousand e-mails," says Reno, who is now at
Plumtree Software
.

Ballmer views product integration as Microsoft's big advantage--how its software will reach from the desktop to servers, databases and the Web and onto phones, handhelds and set-top boxes. But reach means complexity. As it is, the last version of Windows has 50 million lines of code, and Vista will run a lot more.

"Projects were weighed down by integration," says Alexander Hopmann, who quit Microsoft in March to join a home-networking startup, Pure Networks, in Seattle. In 2000 he worked on new storage software for Exchange, a server program that works with Microsoft Outlook e-mail, but the Outlook team, without admitting so, didn't want it. "They sent me a 200-page document that said our technology had to be 100% better than the current stuff. Then it failed, of course, so they did it themselves."

More recently, programmers at the MSN online service were ready to release a search tool letting users sift through their own PCs, but the research lab and the Windows division were working on similar efforts. Some argued that any new tool should wait to be bundled into Vista. Yusuf Mehdi, a top MSN executive, had to dicker inside the company for a month before striking a compromise that let MSN's and Vista's search tools both go ahead.

Ballmer has moved to counter the drawbacks of bigness, pushing employees to focus more on customers and less on internal doings. At the sales meeting in July, former sales chief Kevin Johnson encouraged the crowd to "just say no" to internal requests and meetings. He has ordered all internal sales meetings to occur only on Tuesdays, so his reps can pitch to customers the rest of the time.

Some customers say Microsoft is more responsive than it used to be. "The old Microsoft took its customers for granted," says J.E. Henry, tech chief at the Regal Cinema theater chain. "They didn't care what we had to say about total cost of ownership, security, risk. After Steve took over, I saw a complete turnaround."

In its days of complacency, IBM had a no-layoff policy. Ballmer, determined not to let deadwood accumulate in Redmond, Wash., lets go of 6.5% of the workforce every year for inadequate performance. He makes a valiant effort to penetrate the management honeycomb to rally the worker bees. He writes a quarterly overview, e-mailed to all employees, and also does several Webcasts a year. He regularly holds what he calls "skip-level one-on-ones" with individuals or groups of employees who are up to ten levels below him. Another method: "wallows" (his word)--impromptu meetings focused on the bigger issues; he recently challenged the Microsoft Business Solutions team to describe how it will target medium-size companies.

Ballmer has put in place half a dozen internal surveys to give employees a sense that their opinions are heard. The Microsoft poll is an anonymous survey with 60 statements that employees are asked to rate, from "strongly disagree" to "strongly agree," on such topics as accountability and performance rewards. Last year Microsoft got 70,000 written responses to various questions.

Customer satisfaction gets measured annually. Employees meet with managers every August to plan up to six "commitments" for the upcoming year. Each job is assigned to one of 15 levels--the system sounds a lot like civil service pay grades--and given a "competency tool kit," a list of the skills an employee of a particular type and level should have. At annual performance reviews, managers are compelled to rank employees on a scale of 1 to 5. Says Hopmann, the escapee now at Pure Networks, "There's a bureaucracy that over time has developed these rules. It has become a huge morale problem."

Morale would no doubt be better if Microsoft were still growing at 50% a year, as it was doing 15 years ago. Not counting one-time gains from option accounting, net in the fiscal year just ended was up only 19%.

The Xbox game console is hot, but its division has lost $4 billion in four years and isn't yet in the black. The mobile-software division, also losing money, has just a sliver of the market for cell phone handsets. Microsoft Business Solutions, after acquiring Great Plains Software for $1.1 billion and Navision for $1.4 billion, is supposed to deliver $10 billion in sales by 2010. At its current 6% growth rate, MBS will attain that goal in 43 years.

Give us time, Ballmer says. "You could say 1995 to 2000 was about us winning on the desktop. Then 2000 to 2005 we won and drove the server market. And the next five years is all about driving and winning the Web," he says. Yet it was in 1995 that Gates issued his "tidal wave" memo, a clarion call to the Microsoft hordes: "Like the PC, the Internet is a tidal wave. It will wash over the computer industry and many others, drowning those who don't learn to swim in its waves." A decade later, is Microsoft poised to win the Web? Not by any measure.

Then again, Microsoft is so vehemently competitive that it could yet prevail in videogames, searching and servers. Microsoft is "the world's largest startup," says star programmer Ray Ozzie, who wrote Lotus Notes and joined Microsoft in April when it acquired his startup, Groove. "No one seems to feel comfortable in their own skin here. It's weird. They still need to succeed."

He observes what Ballmer is too proud to say: "The top executives get the potential Microsoft has. But the next tier of employees doesn't because of the stock price."